Indirect vs. Direct Goods and Services. What’s the Difference?
Let’s say that, instead of procurement services, you produced soda bottles instead. What would your spend management goals be? Or, what if you are looking to hire an “A Team” for your department? What would your spend management goals be then? How would they be different?
Understanding the distinction between direct and indirect goods and services will help you determine your spend management goals and set your roadmap. Like so many things in the world of procurement, there are no hard and fast rules for what the terms “direct” and “indirect” goods and services mean. That said, we have created a guideline (listed below) to help you distinguish the difference between the two categories.
Direct Goods and Services
- Typically, a tangible item that includes measureable specifications (size, type of packaging used, etc.) and ties to a bill of material.
- It falls under the umbrella of supply chain because the materials to make the product are direct from suppliers. Specifically, it falls within procurement, who will own the supplier relationships.
- The cost of the item can be broken down into raw materials, conversion, packaging and shipping.
- You can forecast total direct spend based on your projected sales via your ERP system.
- Samples of direct goods and services categories include: cost of goods sold, chemicals, packaging, metals, plastics, third party manufacturing, sub-assemblies, and transportation.
When dealing with direct goods and services, you share goals with the supply chain team. Those goals may include:
- lowering costs
- decreasing waste,
- driving savings to the bottom line.
While these goals are important and should be kept top of mind, they are not your only priorities. Other important considerations should include: reducing lead times, managing inventory, risk mitigation/management, supplier led innovation, and sustainability.
Indirect Goods and Services:
- May or not be a tangible good. Often, they have no measurable specifications and no bill of material, but will include a statement of work.
- There is no pre-determined amount to buy. Instead, the cost is determined by the perceived value of the item. For example, when sourcing talent for your organization, you need to estimate compensation for a worker based on the level of value you believe they will bring to the organization.
- You can forecast the cost of indirect goods and services via a budget holder (a senior manager or director of the business).
- Often, indirect goods and services are managed by a three-way relationship:
- a business partner
- a supplier
- the procurement department.
- Samples of indirect goods and services categories include: marketing services, media & advertising, IT, research and development, travel & entertainment, facilities services, contingent labor, consulting, transportation, capital, and fleet management.
With indirect goods and services, your goals may vary by group or by project. For example, your department’s goal may be to lower costs, while another group may increase budget to reduce time spent on the project. Unfortunately, your goals may be harder to achieve because the indirect space sees more “one-time” buys than the direct space, which means there is often no historical spend by which to make a fair comparison. Achieving spend management goals in this space may mean focusing more on cost avoidance rather than savings.
Direct and indirect goods and services are both critical to your business. When you have a stronger sense of understanding what they are, how they are different, and how your understanding can be leveraged to achieve your spend management goals, the result is significant contribution to your company’s overall success.